This is meant to reassure policy makers and the public that the
Fed is prudently protecting its balance sheet against losses.
Protection against losses at the Fed is important to the public
for three reasons.

Fed profits are an important source of revenue for the US
Treasury. Any shortfall in that revenue will force the Treasury
to borrow more or raise taxes.

Losses at the Fed could hurt its flexibility when it comes to
policy decisions. Despite all appearances, the Fed does not have
unlimited flexibility to manipulate interest rates without
triggering inflation. If the Fed is facing serious balance sheet
losses, it will be more difficult to continue low interest rates
to combat a recession.

The prestige of the United States is on the line here. A
faltering Fed will sap confidence around the world in the US,
making it harder for both private and public institutions to
raise capital in both debt and equity markets.

In short, the American people are hugely exposed to any losses at
the Fed.

Which is what makes it so bizarre that we’re meant to be
reassured by the fact that the Fed’s exposure to mortgage
securities is limited by taxpayer guarantees from Fannie, Freddie
and Ginnie. It’s taxpayer losses all the way down.

To make the situation even more mind boggling, we’ll add a
further twist. The massive borrowing of the US government is
supported, in part, by the Federal Reserve buying Treasuries.
That is, the Fed is funding the very same government it is
relying on to fund any losses from mortgage securities.

Look at it this way. Deep losses in the Fed’s mortgage portfolio
would trigger payments from the Treasury backed mortgage
insurers, which would have to be funded by the issuance of debt,
some of which would have to be bought by the Fed to keep the
borrowing costs down.